Now the Fed is Trying to Give Away Cash

I honestly don't know what to think. A few years ago when Alan Greenspan dropped the key interest rate to 1 I thought it was a huge mistake. I did not think that the situation warrented it, and I was concerned about the flood of money into an economy based on perceived wealth. Now today the Federal Reserve has again cut its target for overnight interest rates, but this time they have dropped the rate from zero to 0.25%. I'm not even sure what that means, is it zero or is it 0.25%?

Whatever it is, its a pretty unconventional action. I know that the Fed and Bernanke are trying to do everything they can to lift the economy out of a year-long recession, but is this the right action? Cutting interest rates to 0.25% or 0% is not going to resolve any of the fundemental problems in the economy, other than to provid banks with very cheap money. I would not have done this unless there was a guarantee that the banks would drop their interest rates.

Paul Krugman writes in his blog today:

ZIRP!

"That’s zero interest rate policy. And it has arrived. America has turned Japanese."

"This is the thing I’ve been afraid of ever since I realized that Japan really was in the dreaded, possibly mythical liquidity trap."

"Seriously, we are in very deep trouble. Getting out of this will require a lot of creativity, and maybe some luck too."

With the Fed's key rate now essentially zero, the central bank is moving into uncharted territory. Nonetheless, Fed Chairman Ben Bernanke has made it clear the Fed isn't running out of ammunition to fight the worst financial crisis since the 1930s. Except that it basically has.

Bernanke claims that the Fed is exploring using tools other than rate cuts to revive the economy. Trouble is he does not have the authority or clout to really do anything else. Bernanke and his colleagues wrap up a two-day meeting Tuesday, but no one is sure what will come out of it.
The Fed is trying to send a message that it is ready to do everything in its power to stop the economy's free fall, but they have pretty much used up all their power.

Greenspan Denies Economic Crisis His Fault

Speaking on Capitol Hill today, former Federal Reserve Chairman Alan Greenspan conceded that the economic meltdown had revealed a major flaw in his economic thinking and left him in a “state of shocked disbelief,” but he denied the nation’s economic crisis was his fault.

Now I have to admit for years I bought this guy's theory. I believed in the Milton Friedman theory of economics, but in 2000 really turned, as Greenspan set aside intelligent economic policy for partisan belief. The worst thing that ever happened to Greenspan was he had a Republican President. If he had had Gore in office, he would have remained a brake on outlandish economic policy. Instead he felt the need to back an insane tax policy, and dumped cash into the economy by keeping interest rates way to low for way too long which increased the housing bubble.

Greenspan of course wants to forget this. He stepped down in 2006, is now calling the banking and housing chaos a “once-in-a-century credit tsunami” that led to a breakdown in how the free market system functions, and tried to give the impression that no one could see it coming. But this is not true, economists like Paul Krugman were warning of this.

During today's hearings Greenspan warned that things in the economy would get a lot worse before they get better, with rising unemployment and no stabilization in housing prices for “many months.”

Tough economic reports that came out today backed Greenspan's ascertion. New jobless claims soared to just under 500,000 for last week, and Goldman Sachs, Chrysler and Xerox all said they were cutting thousands more jobs.

Republican Greenspan, who has always been a staunch believer in the Milton Friedman theory of economics, and in free markets, proposed that government consider tougher regulations, including requiring financial firms that package mortgages into securities to keep a portion as a check on quality.

Greenspan did acknowledge under some very intense questioning that he had made a “mistake” in believing that banks, operating in their own self-interest, would do what was necessary to protect their shareholders and institutions. Greenspan said that his theory had “a flaw in the model ... that defines how the world works.”

Greenspan was wrong in 2004 when he rejected fears that the five-year housing boom was turning into an unsustainable speculative bubble that could harm the economy when it burst. During that time Greenspan maintained that home prices were unlikely to post a significant decline nationally because housing was a local market. Today he was forced to admit this was wrong.

Again under some tough questioning Greenspan was asked to defend a variety of actions he took as Federal Reserve chairman; like resisting recommendations to use the Fed’s powers to crack down on subprime mortgages, for one. He was asked why he opposed efforts to impose regulations on derivatives, the complex financial instruments that include credit default swaps, which have also figured prominently in the current crisis.

He tried to defend himself by saying that outside of credit default swaps, the bulk of financial derivatives had not caused major problems. This shows he still is not really up to speed on this crisis. He said the boom in subprime lending occurred because of the huge demand for investment opportunities in a global economy, and he blamed the crash on a failure by investors to properly assess the risks from such mortgages, which went to borrowers with weak credit. Again he really has no idea what this financial crisis is about, and what needs to be done to fix it.

Today on her MSNBC show Rachel Maddow talked to Rep. Henry Waxman, chairman of the House Committee on Oversight and Government Reform, about Greenspan’s testimony.


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